What is a Total Expense Ratio?
The total expense ratio (TER) is a measure of the entire cost of a fund to the investor. This varies from year to year.
Annual Fund Operating Expenses mostly referred to as the expense ratio, is that the percentage of assets payable to the fund manager (i.e. AMC).
Total costs can cover multiple fees like purchase, redemption, auditing, and other expenses. The TER, calculated by dividing the whole annual cost by the fund’s total assets averaged over that year, is denoted as a percentage.
The asset manager, with the assistance of a team of analysts and other experts, allocate, manage (including the auditor and adviser fees) and advertise the fund to optimize returns and manage risks.
If the funds’ assets are small, then the expense ratio may be high. This is because the fund has got to meet its expenses from a restricted or a smaller asset base.
In the same way, if the net assets of the fund are increased, then the expense percentage is ideally decreased.
What are the Components of Total Expense Ratio?
The total expense ratio includes numerous charges for smoothly running the mutual fund scheme.
There are three major types of expenses as a part of the Total Expense Ratio.
A) Management Fees
Mutual funds require the formulation of investment strategies before actually investing money in the underlying assets.
Fund managers need to possess a high level of educational, relevant fund management experience, and professional credentials.
On average, this annual fee is about 0.50% to 1% of the funds’ assets.
TER is the measure of all the expenses associated with running a scheme. These can include:
- Management fees, probably the single largest item in the TER of a fund.
- These fees cover items such as fund manager salaries and research fees.
- Fees paid to trustees, registrar and transfer agents, custodians, personnel of the trustee and Asset Management Company, etc.
B) Administrative Costs
They can vary greatly and are expressed as a percentage of fund assets.
The administrative costs are the expenses of running the fund are as follows:
- Brokerages and taxes in transacting the securities of the scheme.
- Any other operational expenses like rent, electricity, communication, etc. in proportion to the assets of the scheme.
- Legal and accounting fees contain the following parameter would include keeping records, customer support, and service, information emails, and communications.
C) Distribution Fees
Many mutual funds collect the distribution fee for advertising and promotional purposes.
- Sales and marketing expenses.
- Charges are their shareholders to market and promote the fund to the investors.
Advantage of Total Expense Ratio
- It indicates the percentage of sales to the total of individual expense or a group of costs.
- A lower rate of expenses means more profitability.
- AMC must be managed within limits specified under regulation is good.
- Lower charges attract investors.
Disadvantage of Total Expense Ratio
- A higher rate means lesser profitability.
- High rates cut the profit for a year.
- The less yield sector, affect negatively due to these expenses.
- It depends on AMC providers to provide the best services.
Formula of Total Expense Ratio
Example of Total Expense Ratio
If you invest Rs.100,000 in a fund with an expense ratio of 1%,
Then you will have to pay to the fund house Rs.1,000 to manage your money.
It can be said that if a fund earns 10% and has a 1% TER, it would mean a 9% return for an investor.
The mutual fund’s NAVs are reported after netting off the fees and expenses and hence, it’s necessary to understand what proportion the fund is deducting or charging as expenses.
Mutual fund expenses should be range from 0.1% to 3.5% for tax saving funds in India.
Interpretation and Analysis of Total Expense Ratio
Expenses can vary significantly between types of funds. The category of investments, the strategy for investing, and therefore the size of the fund can all affect the expense ratio.
A fund with a smaller amount of assets usually features a higher expense ratio because of its limited fund base for covering costs.
International funds can have high operational expenses because they will require staffing in several countries.
Large-cap funds, with a median expense ratio of 1.25%, are typically more cost-effective than small-cap funds, which average 1.4%.
Expense ratios indicate what proportion the fund charges in terms of percentage annually to manage your investment portfolio.
If you invest Rs.40,000 in a fund that has an expense ratio of 1.5%, then it means that you need to pay Rs.600 to the fund house to manage your money.
In simple words, if a fund earns returns equal to 14% and has TER of 2%, then you will make a return equal to 12%.
The Net Asset Value (NAV) is the fund obtained subtracting all the fees and expenses. Hence, it becomes essential to know how much are you paying to the fund house.
Expense Ratio Limit by SEBI
All expenses are of Regulation 52 of SEBI Mutual Fund Regulations.
As per these regulations, the whole expense ratio (TER) allowed is 2.5% for the primary Rs.100 crore of average weekly total net assets.
2.25% for subsequent Rs.300 crore, 2% for succeeding Rs.300 crore, and 1.75% for the remainder of the AUM.
The limit for debt funds is 2.25%. Securities and Exchange Board of India permits all the mutual funds related charges on 30 basis points more as an incentive to infiltrate in smaller towns (B15 Cities).
These cities also enjoy a further 20 basis points as exit load charges.